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Generational Dynamics Web Log for 16-Sep-2021
16-Sep-21 World View -- China's Evergrande financial crisis threatens China's financial stability

Web Log - September, 2021

16-Sep-21 World View -- China's Evergrande financial crisis threatens China's financial stability

Will there be a government bailout?

by John J. Xenakis

This morning's key headlines from

China's Evergrande financial crisis threatens China's financial stability

Year to date performance of Chinese stocks, battered by new Chinese regulations in numerous sectors (Reuters)
Year to date performance of Chinese stocks, battered by new Chinese regulations in numerous sectors (Reuters)

China Evergrande Group is an enormous real estate construction firm that has built millions of homes and other structures in China, and which has expanded into other areas, such electric vehicles, a theme park, a soccer club, a food company, and other areas. However, Evergrande is now close to default because of its massive debt, and its inability to meet its obligations.

China's Evergrande financial crisis has been bubbling for several months, but reaching a turning point on Monday when the company issued a statement denying that it was close to bankruptcy, but saying that it was going to hire financial advisers to explore "all feasible solutions" to its crisis. However, they would not guarantee that the company will meet its financial obligations. That announcement provoked protests at Evergrande offices across the country.

Evergrande appears to me to be a giant Ponzi scheme, where new debt is incurred to cover old, out of control debts.

So Evergrande as a construction firm has completed nearly 900 commercial, residential, and infrastructure projects. But it has 1.5 million unfinished properties, for which down payments have been collected, but many of which have stopped construction, for lack of funding. For years, Evergrande has apparently used down payments for new homes and projects to fund completion of previously committed projects, leaving no money for the new projects.

Millions of ordinary homebuyers who made down payments on new home construction are now facing losing their down payments, and getting no homes. According to press reports, Evergrande now has about 900 unfinished projects, and there are about 1.2 million people waiting to move in.

In order to fund its Ponzi scheme, Evergrande for years has been offering investment opportunities in "wealth management products" (WMPs), which are offered by many Chinese banks and financial institutions, and which are are unique components of China's shadow banking system. A retail investor can invest in a WMP, which supposedly guarantees a high rate of return, but which is not directly backed by any solid asset, such as real estate. Evergrande pays the WMP through profits from its real estate business and by issuing its own bonds. But if the real estate business is not making profits, and if its bonds are losing value in the financial markets, then Evergrande will default on the WMPs.

Every Ponzi scheme depends on an accelerating stream of cash to fund further sales to meet previous debt obligations. As soon as there's a slowdown in the incoming stream of cash for any reason, like a recession or new regulations, then the Ponzi scheme crashes. That seems to be where Evergrande is now. This means that homebuyers, lenders, bondholders and retail investors are all subject to some or all of their investments. According to some reports, bondholders will lose 75% of their investments.

Will there be a government bailout?

As things stand now, Evergrande is going to collapse, possibly into bankruptcy but at least into massive restructuring. With millions of people losing some or all of their investments, this could lead to China's dreaded "social unrest." Evergrande's headquarters are located in Shenzhen, which is on the mainland adjacent to Hong Kong, in southern China which has historically been the crucible of China's previous massive rebellions, including Mao's Communist Rebellion (1934-49) and the huge Taiping Rebellion (1854-64). The Chinese Communists are well aware of this history.

The Beijing government may decide that Evergrande is "too big to fail," and bail the company out. But Evergrande has publicly acknowledged $300 billion in debt, and so a bailout would test even the Communist government's resources.

But it's more complicated than even that. For years, there have been news stories about ghost cities where entire towns had been built with homes and stores, all of which remained empty and unoccupied. Many individuals purchased these homes, not to live in, but as an investment, hoping to cash in when they finally became occupied and increased in value. Instead, they're now worth much less than their original prices, and they're sitting empty, with no hope of occupancy.

Another problem is that if Evergrande defaults, then the entire real estate market could collapse, as millions of new properties could possibly come on the market at the same time.

So a bailout might cost China's government considerably more than the $300 billion in debt.

China Huarong Asset Management bailout

So bailing out the Evergrande Ponzi debt might be too expensive even for China. Even worse, it may result in contagion. Investors in other large financial firms with huge exposures might demand similar bailouts.

It was just last month that Beijing executed a much smaller bailout. China's Huarong Asset Management announced a $16 billion net loss for 2020. After months of saying nothing, the Chinese Communist government finally gave in and agreed to a bailout, for fear that a Huarong bankruptcy could destablize China's financial system.

The way that the bailout would work is that Huarong will issue new shares to five state-owned companies -- Citic Group, China Insurance Investment, China Life Asset Management, China Cinda Asset Management and Sino-Ocean Capital Holding. By purchasing these shares, the five state-owned companies would provide a huge cash infusion to Huarong.

So if that worked for Huarong, would it also work for Evergrande? Well, Huarong lost a mere $16 billion, while Evergrande is at least $300 billion in debt, and possibly much more. So it may not even be possible.

Generational Dynamics analysis

There are several typical behaviors that generations and populations exhibit during a generational Crisis era, like the one we've been in since the beginning of the century. At this time, all the people who survived the previous generational crisis war (World War II) have all died or retired, and the new generations in power (Gen-X, Millennials) have no memory of the lessons learned. They forget the nationalism and xenophobiat that caused the World War II, and they forget the profligacy that resulted in the previous major financial crisis (1929). They say that history doesn't repeat itself but it rhymes, and we're seeing that now.

I've written much about China's increasing xenophobia and nationalism directed at Japan and Taiwan, and I won't repeat it here, but I want to focus on profligacy.

The United States is already %28 trillion in debt, and is contemplating new legislation that will add $5 trillion more to the debt. That's absolutely ridiculous, and will result in the worst financial crisis in the history of the world.

China is also incurring historically high levels of debt, with no end in sight. At some point there will be a major financial crisis in China, with tens or even hundreds of million people losing their life savings as the crisis spreads from company to company.

That will give rise to the Beijing's nightmare scenario, massive social unrest, possibly turning into rebellion.

China's Macau crackdown and contagion to United States

Macau is similar to Hong Kong in that it is a special administrative region in southern China. However, Macau is the gambling capital of Asia, competing against Las Vegas for customers.

On Tuesday, China's regulators announced changes to the gaming law that would give the government much greater control over the casinos, and possibly a larger share of the earnings.

You may think that this is an internal Chinese matter, but it's not. Almost all the casinos are operated by American companies -- Sands China, Wynn Macau, Galaxy Entertainment, SJM Holdings, Melco Entertainment and MGM China. And Macau stocks lost a third of their value, around $14 billion, because investors feared that China would impose tighter regulations.

This illustrates how tightly interlocked the Chinese and American companies are, and a global financial crisis in one country will cause a chain reaction financial crisis in the other.


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(Comments: For reader comments, questions and discussion, see the Generational Dynamics World View News thread of the Generational Dynamics forum. Comments may be posted anonymously.) (16-Sep-2021) Permanent Link
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